Thursday, June 25, 2015

In light of the persistent media focus on income and wealth inequality, which has surged since the publication of Thomas Piketty's Capital in the Twenty-First Century, and about which I and many others have written in protest, I can't help but highlight an under-appreciated and continuously growing gap between the prices of durable goods and all other things under the economic sun. The chart says it all:

The data for this chart comes from the BEA's calculation of the price deflators for Services, Non-durable, and Durable Goods. Prior to 1995 there were times when some prices grew more or less than others, but post-1995 is the first time since the Depression that the prices of some things fell continuously while others rose.

The likely culprit for two decades of persistent deflation in the durable goods sector? China comes to mind, along with huge leaps in technological progress. In the process of industrializing and modernizing its economy, China figured out how to make things much cheaper than anyone else in the world by using Western capital and technology to greatly enhance the productivity of hundreds of millions of its workers that were formerly vastly underutilized.

Is this a bad thing? Well, let's think about it.

Consider this quick and dirty analysis: The deflator for Services is a decent proxy for real wages, since the service sector of the economy is far larger than the manufacturing sector and the major component of services is labor. As proof, I note that real personal income over the same period as the chart rose by 73%, only slightly more than the 66% rose in the prices of services. Now compare the 66% rise in the price of services to the 32% decline in the price of durable goods. That huge and "unequal" gap means that a unit of work today for the average person buys him or her 2.44 times as much in the way of durable goods as it did in 1995. Put another way, the prices of durable goods on average have declined some 60% relative to incomes.

While grossly "unfair" to US businesses individuals engaged in the manufacture of durable goods, this huge, unequal and growing gap in prices has been the biggest boon in history to nearly everyone else. Thanks to this rising inequality, just about everyone you see on the streets today carries a smartphone, a device capable of feats that were unimaginable two decades ago, and which can be bought for about two week's worth of work at the prevailing minimum wage. Meanwhile, thanks to its export earnings, China today is importing roughly 15 times as much from the US as it did two decades ago.

Inequality of wealth and prices is everywhere these days, and thank goodness. Andy Kessler in today's WSJ reminds us that great inequalities of wealth almost necessarily spring from great advances in technology, manufacturing, services and general productivity.

A company’s profits are the minimum value of the work it does for you and for society. Google, to take another example, generates huge profits. CEO Larry Page has an estimated net worth of $30 billion. But Google offers you a valuable service, and society benefits to the tune of trillions, yes trillions, of dollars in commerce that happens thanks to Google searches, mail and maps. Similarly, an iPhone 6 is worth a heck of a lot more than $600; you can hail a car, trade stocks, call your mom, all without being chained to a desk.

Everyone should stop focusing on an entrepreneur’s wealth and instead focus on the value the customers gained from his products. I can’t dig for oil, let alone frack, but I am happy to pay Exxon a premium for my high-test gas. Collectively, we are richer because of Exxon. So inequality is not a bug of capitalism; it’s a feature.

Your comparison of the falling prices of Durable Goods compared with the rising prices of Services (which are less susceptible to foreign competition) is dramatic. Dr Ed Yardini blog post today concerned stagnant US productivity. He made these observations:

"The easiest and best productivity gains in services-producing industries may have been gotten, and extracting more out of them is getting harder to do. Here are the relevant data points:

(1) The ratio of real GDP for goods to goods-producing payroll employment was at a near-record high of $267,810 per worker during Q1 (saar), up 1.7% y/y. The similar ratio for services rose to $81,372 per worker, down 0.1% y/y.

(2) Since the start of the data in 1947, the goods-producing “productivity” ratio is up a whopping 908%, while the comparable rate for services is up only 77%.

Since it is agreed that Services account for more than 70% of the US economy, the low productivity growth in Services drags down total US productivity.

William, we could import more services workers from Mexico and Asia who will work for lower wages. This will be an automatic boost in the productivity ratio. Adding population in and of itself increases GDP as well.

Lots of inequality is arising from hedge funds. I read that the majority of the new top 5% wealthy individuals are in the hedge fund /wall street industry and not technology. In the past the wealthy class were typically business owners but not anymore. Hedge funds create lots of wealth for a few individuals and they do not create very many jobs.